Federal Reserve Bank of New York
President William C. Dudley said he “cannot imagine” the U.S.
central bank buying European sovereign debt to combat the
crisis, though it has the legal authority to do so.

“The bar to doing that would be extraordinarily high,”
Dudley, 58, said today at a hearing of a House Oversight and
Government Reform subcommittee in Washington. “We have never
gone out and bought large portions of sovereign debt in the
history of the Fed that I’m aware of.”

Dudley defended the Fed’s currency-swap lines to foreign
central banks under questioning from lawmakers, saying that the
loans are “about helping ourselves.” Dudley also said he
doesn’t anticipate the Fed will undertake additional steps to
curb the impact of Europe’s crisis, though it is prepared to
boost liquidity to U.S. banks if necessary.

“It’s really their problem to solve,” Dudley said. “The
Federal Reserve is doing what we think is appropriate to support
lending here in the United States.”

The Fed’s swap lines to foreign central banks surged by $52
billion to $54.3 billion this week after the Fed and five other
central banks lowered borrowing costs by a half-percentage point
in a coordinated action. The Fed lends dollars through the swaps
to other central banks, which auction them to local commercial
banks and give the Fed foreign currency as collateral.

Flow of Credit

“This is about ensuring the flow of credit to U.S.
households and businesses,” Dudley said. “It is in the U.S.
national interest to make sure that non-U.S. banks that are
judged to be sound by their central bank are able to access the
U.S. dollar funding they need in order to be able to continue to
finance their U.S. dollar assets.”

Less than two hours after Dudley’s testimony ended, Fitch
Ratings said it may cut the ratings of nations from Italy to
Spain and Belgium as Europe’s debt crisis defies the
“comprehensive solution” pledged by the region’s leaders.

U.S. stocks pared gains after the Fitch statement, while
Treasuries extended their advance. The Standard & Poor’s 500
Index added 0.3 percent to 1,219.42 at 1:03 p.m. New York time,
after rising as much as 1.3 percent. Yields on 10-year Treasury
notes fell six basis points to 1.85 percent.

Countries that share the euro face “a critical problem of
confidence” in the long-term sustainability of fiscal accounts
for some nations and in the stability of their banking systems,
Steven Kamin, the Fed’s Director of International Finance, said
at the same hearing.

“It is incumbent upon European authorities to address all
these issues, and indeed they have taken a number of steps on
all three fronts,” Kamin said.

‘Very Alert’

The Fed and other regulatory agencies are “very alert” to
the risks of short-term European bank debt held by U.S. money-
market funds, which have “been substantially reducing their
exposure” to the most vulnerable European economies, Kamin
said. The Fed swap lines can work as a backstop against market-
liquidity problems, helping European financial institutions get
the dollar funding they need, he said.

Lending through the swap lines peaked at $586 billion in
December 2008. The swaps are separate from Fed emergency loans
to banks and other businesses that peaked at $1.2 trillion the
same month, including about $538 billion that European financial
companies borrowed directly, according to a Bloomberg News
examination of available data.

Identities of Borrowers

Representative Patrick McHenry, the North Carolina
Republican who heads the subcommittee, said after the hearing
that getting information on which European banks are obtaining
loans through the Fed’s swap lines is a “big concern.” While
the transactions with other central banks are all disclosed, the
Fed doesn’t track where the dollars ultimately end up, and
European officials don’t share borrowers’ identities outside the
continent.

“I think it’s reasonable, if the Fed is extending the swap
line to a central bank, that they actually have similar
disclosures that our central bank requires from counterparties
within our country,” McHenry said to reporters. “With less
information, markets become less confident.”

Fed Chairman Ben S. Bernanke signaled this week he’s
concerned that Europe’s sovereign debt crisis will damage a 2
1/2-year expansion in the U.S. and that the central bank is
prepared to provide easing if needed. The Federal Open Market
Committee said after meeting in Washington on Dec. 13 that
“strains in global financial markets continue to pose
significant downside risks to the economic outlook,” and that
there is an “apparent slowing in global growth.”

‘Fiscal Capacity’

Dudley said Europe has the “fiscal capacity” to meet its
challenge, which he said is “really a political one.” He said
he doesn’t see the European Union dissolving.

“You really have to solve two problems,” Dudley said.
Regulators need to “make sure the banks have enough capital,”
and “you also have to get each country on a sustainable fiscal
path so that people are comfortable that the sovereign debt they
hold is going to be money good.”

The stress tests being undertaken by regulators in Europe
are “a very important step” in bolstering confidence in the
financial system, Dudley said. The Fed is also putting U.S.
financial institutions through a “very severe stress test,”
designed to ensure they can “withstand a very bad economic
environment regardless of the source of the stress,” he said.

It will be easier for Spain and Italy to achieve fiscal-
consolidation than for Greece, he said.

“As you go from the peripheral countries to the core, the
debt challenges become much more manageable,” Dudley said.
“They have to do substantially less than what Greece has had to
do,” and “what Spain and Italy need to do is completely
achievable.”